The Value Perspective Podcast – with Richard Oldfield

SA: Welcome, Richard Oldfield. Thank you very much for coming. It is a pleasure to have you here.

RO: It is very nice to be here. Thank you for having me, Simon.

SA: Our pleasure. Given you have enjoyed a very long and successful career, I thought we would start by asking what you would say is the most important lesson you have learned?

RO: Above all, patience. One of my mentors is a man called Peter Cundill, who was a great value investor – Canadian, sort of top of the charts by the time he retired – and he used to say, Patience, patience, patience. And he needed it because there were periods – sometimes, very long periods – when value was out of fashion and he was doing badly. I mean, had he retired in 1999, he would have underperformed the market since he started. So you might say, Well, those first 25 years or whatever, were a bit of a waste – but they weren’t because they were putting in place the portfolio that then rocketed when the tech bubble burst in March 2000.

And I think that is often the way with value – that you get quite long ‘short’ periods of underperformance – in other words, the short periods can turn into something much longer than you ever imagined at the outset. Then when it does turn, it can be rocky – partly because people have departed from that area of the market. So I think patience is absolutely vital. And I do think it is the besetting fault of investors – encouraged, really, by the industry – that people who are in a position to take a long-term view very often don’t.

And in my time – which, as you say, is a very long time! I started working in 1977 and managing money from 1981 – I think the emphasis on volatility has grown and grown, including among people who should not be too worried about volatility, because they are long-term investors. And that, in a way, increases the opportunity because it makes for an inefficiency in markets: people have become evermore short-term and those who are long-term therefore stand a better chance – ultimately – of outperforming. Peter Cundill said something like, I may do badly for quite a long time but I have the last laugh! And he did have the last laugh because by the time he retired, as I say, he was top of the charts.

SA: Like you, Peter Cundill is behind another very good book on value – although I don’t think he wrote it himself, did he?

RO: He didn’t write the book, no. Christopher Risso-Gill wrote There’s Always Something to Do: The Peter Cundill Investment Approach. And that is another good motto – there is always something to do. Even when the portion of markets in which people specialise gets overvalued, there is always something somewhere.

SA: The lack of patience in the industry is tricky – whether it is down to the way people look at risk, the frequency of reviews or performance reports – and I know you have turned down clients who ask for performance reports too often. How do you think we can instil a longer-term outlook or framework? Or do you just have to accept it is an advantage to those who have that and there are only so many clients who do – and they are the ones you want?

RO: Well, it is certainly the latter – it is an advantage to those who do truly have a long-term view. All you can do as a manager, if you are truly long-term yourself, is try to be very clear with clients when they come to you that this is what they can expect. They can expect plenty of downs and not very rapid turnover to try and get out of trouble – but they can expect a consistent investment philosophy. Now, there is no monopoly on which philosophy is going to be right but a consistent investment philosophy stands a much better chance in the long run than a non-philosophy or a non-style.

I don’t think it is so much now but it used to be the case in the UK that managers were reluctant to call themselves ‘value’ or ‘growth’ or anything else because they didn’t want to be popped in a box and then not be able to escape. So a lot of very good managers would say that they didn’t have any particular style – they were eclectic and various. I don’t think that really reflects human nature, though – I think people do have, in their blood, a certain sort of disposition and I also think it is a disadvantage to long-term performance. It may be an advantage to short-term performance but it is a disadvantage to long-term performance – trying to move between styles – and then you lose your compass. Having a compass is very important.

SA: Yes. We have found that having a compass – and the clients having the same compass – means, in a difficult patch, you can keep going and then they get the reward by sticking with you.

RO: I agree. Jeremy Grantham, who is a renowned practitioner – British, lives in Boston, founded GMO – said even the best clients have maybe a three-year average patience. And, in the period to 1999, I think GMO lost something like two-thirds of its business. I think he underrates it – if you are very clear about the risks of your approach and its long-termism, on the whole, clients will see you through bad patches, even quite long-lasting bad patches. Still, there is a necessity for a constant reiteration of the long-termism of the manager.

How – and why – has the idea of risk evolved?

SA: And that is your point on the benefit of having a consistent approach as well. In terms of risk, I believe we both share the same view that risk is ‘a permanent loss of capital’ – but how many clients do you think truly share that interpretation? And why do you think – I imagine, over your career – that has become the less accepted definition of risk and various Greek letters have taken over?

RO: I think there are enough clients – let’s put it that way! – who take that view of risk being a permanent loss of capital rather than volatility. There are enough clients who would be with Seth Klarman and the people we have mentioned, who would say that, very often, the risk of an asset is much lower after a period of volatility of the wrong sort – in other words, the asset price has gone down a lot more than ordinary market volatility but the risk is lower because the valuation is lower. One of the sources of low risk is low valuation. I have forgotten the second part of your question!

SA: I might have done as well! Has the definition of risk changed over time?

RO: It has changed over time – and I think ‘active risk’ was a desperate invention. I remember I was at Mercury Asset Management when it suddenly appeared on the scene – the notion of active risk. Say you have a quarter in which Coca Cola is down and you have a quarter-percent overweighting in these very diversified portfolios – in an institution, by the wave, for which I had, and have, enormous respect. It was a wonderful place. All the same, when it became very big, portfolios were very, very diversified – they were not in the least bit concentrated, with hundreds of holdings – and then active risk came along.

And then, after the quarterly review, there would be pressure – Coca Cola having underperformed and the weighting being a quarter-percent over the market weighting – to reduce to the market weighting. And to control active risk, to control it at a low level – as soon as you begin to talk about it, the inclination is to keep it low – well, my inclination has always been to keep active risk high because active risk is a sign of the manager trying. Not everybody who tries will succeed and, as we know, rather as it is with driving cars, we are all overconfident. As car drivers, 95% of us think we are above-average; and, as managers, 95% of us think we are above-average – but at least you have got to try.

And those who are driven by the prevalence of active risk to ‘index hug’ are not trying, in my view, and do not deserve the fees. And active risk was a misnomer, really. It started life as ‘tracking error’, for a very good reason – because it measured the degree to which an index fund differed from the index. And naturally, if it did differ from the index, it was an error because it was supposed to imitate the index. Active risk then became a synonym for tracking error and was used by the active management industry and I think it has been, on the whole, very damaging. I mean, when I used to interview managers, I would be very pleased if they didn’t know what their active risk was.

There is now a new measure – active share – which I think is a better number but it needs to be very high to demonstrate the manager truly is ignoring the benchmark – ‘ignoring’ is not quite the right word ... is not basing his or her investment strategy and commitments on the basis of what the benchmark consists of. That, to me, is one of the marks of ‘properly trying’ – that you should not be imitating or worrying about hugging the benchmark.

SA: It is so stark – and your book, Simple but not Easy, is very good for having a lot of common sense to it. I always think, if you walked out onto the street and told someone ‘low risk’ was having a more similar portfolio to the benchmark – I mean, it doesn’t make any sense. Yet, it has kind of taken over.

RO: It has. And, in my book, I talk about people who hug the benchmark ‘standing on the coattails of a lunatic’ because you end up relying on how the index comes about and the way in which index committees behave. They are trying simply to provide a sort of standardised measurement of what the stockmarket does – they are not trying to dictate how investors should invest. And so we had, and we still have, these rather ludicrous positions when, to put it at its most extreme, all the fuddy-duddy stocks – I remember Whitbread was one of the leading ones – were chucked out of the index in March 2000. Their prices had gone down, their market capitalisations had fallen and so they had fallen out of the index.

And a whole lot of new and exciting companies were put in the index because their prices had gone up and the market capitalisations had gone up. Six months later, when the fuddy-duddies were up by 25% and the new and exciting companies were down by 25%, the index committee of FTSE reversed that decision and put the fuddy-duddies back in. So, as I say, there is a sort of lunatic quality to the index because it is not trying to dictate – index committees don’t start by trying to dictate what investors should do – but, for an enormous percentage of investors’ money, it has become what investors do. And those who hug the index are doing something even worse because they are charging active fees for something that is really not very active.

Where quality should matter to a value investor

SA: I totally agree. Heading down a slightly different avenue, you talked about patience being one of the most important lessons but are there anything any stark areas where you think experience has improved you and your teams as investors?

RO: No, not really!

SA: You don’t think you have got worse!

RO: I hope not! I mean, there were a few lessons learned along the way – although I am not sure if this is one or something I felt from the beginning. I think quality is important. Now, the word ‘quality’ can be misused to in fact remove the value element from value investing. ‘Quality value’ is a term that is used by many investment managers but I don’t think it is really value – certainly in the sense that Ben Graham meant it. It may be in the sense that Charlie Munger meant it. Still, I think there are elements of quality that are very important to the value investor – and particularly, since the great bargains are very often in the most cyclical companies because their earnings are very volatile, it is very important to have quality of balance sheet.

I don’t know when I learned that but I remember, in 2009, not investing in Rio Tinto because its balance sheet was bad and investing in BHP instead – then, as soon as Rio Tinto’s balance sheet was restored, which was around February or March 2009, I moved into Rio Tinto. So I think the balance sheet is vital because I am not a believer in forecasting – and I could go on about that at length though I won’t unless you want me to! But I think market forecasting is extremely difficult and forecasting earnings is very difficult.

For nine years, I had the great privilege of working in a family office where the beneficiary, Hans Rausing, was not in the least bit interested in financial jiggery-pokery but he was a very, very inspiring man – and he absolutely believed forecasting more than a year or so ahead was a complete waste of time. I mean, the last three or four years have been absolutely ample evidence of that – who could have predicted all these things? So I am not a believer in forecasting. And therefore, if you don’t know when a cyclical company’s earnings are going to recover, if they are very depressed – or become depressed, if they are very buoyant – you have got to have a strong enough balance sheet to see you through what could be a difficult period.

So quality of balance sheets is very important. As for individual lessons, time and time again I have learned something – and then, you know, failed to heed the lesson. I have learned you should judge managements not by what they say, but by what they do. I was always nervous – or I became nervous – of meeting management too much because they are very persuasive people. That is why they are chief executives and chief financial officers – and they are very good at spinning the company’s story. In the days when I was at Mercury, I went to see Walmart a few times and I always came away thinking they were worth two more on the multiples than before I had gone in because they were terrific at spinning the Sam Walton cost-cutting, cost-management story. But on the whole, as I say, it is what they do, rather than what they say they say that matters.

And I made mistakes in this respect – for example, with Tesco, which was quite a long-running mistake for us, where we trusted too much in Philip Clarke, who had inherited a very difficult legacy from Terry Leahy, who had driven the company very hard and to high margins. And, as one of the Marks & Spencer dynasty once said, if you have too high margins as a retailer, you are either going short on customer service or you are charging too much. That was what Clarke sort of inherited and we believed too much his assertion that they could recover to 5.2% trading margins, even though our own work – which was quite rudimentary but it didn’t have to be very elaborate – made us extremely doubtful they could do so. So that lesson of not accepting at face value what managements tell you, which is aspirational, was and is an important one.

SA: I thought we might be going to disagree with each other when you started talking about quality but, when you define it as the balance sheet, we totally agree. I mean, if you have a bad balance sheet, you are just stacking the odds against you when you are in a difficult place. It doesn’t mean you cannot buy things with a bad balance sheet but you do need to be very heavily compensated when you do.

RO: Yes – and you need compensation somewhere else. You need compensation in a management in which you do strongly believe – and not because of what they say but because of what they have done in the past. Or you need compensation in the quality of assets, maybe, and Rio Tinto is a good example. If you are going to invest in a cyclical company – a mining company, producing a commodity with a commodity price – it is very important to have the best possible assets. Those are very important ‘quality’ qualifications to pure value.

Can an investor ever have too much value?

SA: Terming of debt is another important one – for example, when Anglo American got into trouble, they were then able to get out of trouble because they did not have any debt to repay for some time, which gives you a big advantage. Now, you mentioned running the Rausing family office Alta, which I would guess afforded you a rare opportunity to see things from the other side of the fence. What were your thoughts then on the percentage of an equity portfolio that should be allocated to value?

RO: Well, I am value out and out, myself. I mean, I do think it is something you have a disposition to and, from my very earliest days of taking any interest in investment, which was nerdishly young – looking at share prices at the age of 15 – I was interested in low-priced shares, long before I knew what valuations were. Then, as soon as I did discover what valuations were, I was interested in low valuations. So that is one rather sort of sturdy hat – but, if you are managing a portfolio that is very large and needs to be diversified across asset classes and managers and so forth, that is a different sort of hat. So we did not invest or advise on investments exclusively in value. And I do absolutely respect that there are many ways to skin the cat and there are many good growth managers – and, looking at it as a dichotomy, value and growth are the two parts of the barbell.

So we did not have nothing but value managers – and yet I think one would want a preponderance of value always because, over the very long term, value has the best chance of outperforming. I think the figures bear this out – including a wonderful Schroders graph, which I purloined long ago and have used countless times! That is a bar chart, with each bar showing low P/E to high P/E across the X axis, and then return over the next 10 years on the Y axis – and it tells the story beautifully that low valuations tend to lead to higher returns and high valuations tend to lead to lower returns. And that has worked across the ages. It does not always work in short periods – the short periods may be painfully long – but it has worked across the ages.

So there is an advantage in value – in part because it is emotionally difficult – and therefore I think one should always have a preponderance in value. So I would think – and these figures are from the top of my head, rather than any memory of where we were – that one would always want, as a kind of norm, sort of 60% in value. But then there are periods in which there are great opportunities – and, of course, 1999/2000 was one of the greatest of all time, 2009 was another one and the beginning of 2016 was another – when you want to up the ante and add to the managers who are value and take some money away from the growth. Not eliminate, but take some money away. And that has to be counter-trend – it has to be at the moments when value is most unpopular. Equally, be prepared, if the thing comes right to take money away from the value managers.

SA: So, if 60% is your kind of baseline, how far up would you take that?

RO: One might take it as high as, say, 75% – but you wouldn’t want to go the whole hog because no portfolio that is a client’s total wealth should be dependant on one theme only. I do believe strongly in having very committed funds within a portfolio – and not in having index-huggers – but you need to balance because the value manager is going to give you a raw deal for some period. And the client needs to be able to say, Oh, well, I may have this dud over here but at least I also have this wonderful growth manager – so I needn’t worry about sacking the dud. If you don’t give the client that comfort, then the temptation to sack at the wrong time is too great.

And there is this very disturbing statistic – and I am going to make up these figures but they are roughly right – that managers fired outperform managers hired by something like 11% over the subsequent two years. I mean, it is by a large figure – not 11% per annum, but 11% over two years. And why is that? It is because committees, on the whole, tend to fire those who have just underperformed and they hire those who have just outperformed for other clients. And then when that process reverses, they do it again. Some institutional clients have an explicit three-year or five-year term of appointment and they are almost obliged to make that change – and that to me is completely bonkers.

SA: Yes. Now this may be an unfair question – and you don’t have to answer it – while I understand what you are saying, if you are looking after someone else’s money, how much do you think you would have in value, if you were looking after, you know, the ‘Richard Oldfield Portfolio’?

RO: Oh, wholly in value because I don’t have to explain to anybody but me!

SA: It does make it a lot easier – and the ‘Simon Adler Portfolio’ is exactly the same! Fortunately, my wife is not in the investment industry so I don’t have to explain it to her!

RO: So she’s not on the committee!

SA: She’s not on the committee! Well, maybe she is on the committee. I don’t know if I’d be allowed to say ‘not on’ – but certainly she doesn’t demand explanations. But it is interesting, isn’t it, that as soon as one is involved in other people’s money, it is very hard to do what one might do for one’s own. Many people would not go nearly as far as you suggested, with 60%-plus in value – because they are so concerned about the volatility and the difficult years we all know come, it is very hard to give the advice to others that they might follow for themselves, even if it was the best course of action.

RO: It is hard. But it is not just volatility, I think, it is this dealing with human beings. We are all human beings and dealing with the fact that, as I say, if you go a bundle on one particular type of approach – let’s say its value and you have three or four managers who are only value – then, as and when that approach does badly and all those four managers have done badly for five years, it is overwhelmingly tempting to make a change, and that change is probably going to be made at the worst possible time.

On the other hand, in our firm – and in your team – then I would do exactly what I do for myself. I mean, I do that in practice – I am invested wholly in the funds of the firm I managed because I only have to explain to myself. In the funds I managed, meanwhile, I did exactly what I would do for myself – because I expected the client to have some balance somewhere else and so have that comfort they would need when things were going wrong.

The ‘counter-presentational principle’

SA: Yes – it is just extremely sensible. Now, when you were at Alta, presumably you spent a lot of time meeting fund managers and trying to assess their quality, style, philosophy and so on – did you have a firm view as to how you could assess the quality – or lack of quality – of a fund manager?

RO: Yes, we did. We had a little acronym for it, which was ‘PAPE’ – so, ‘philosophy’, ‘approach’, ‘people’ and ‘environment’. You will notice performance was not one of those because the knowledge of performance was always there – you can’t help it being there – but, to depend on performance as a cause of action is very dangerous, because performance is volatile and past performance is no guide to future performance and so on. So we tried to eliminate from our mind, as much as possible, what the immediate past performance had been and to concentrate on the approach of the firm; above all, the quality of the people; and the environment, which is very important.

The sort of environment, if there is any ‘asset-gathering’ push in the firm, if there are endless committees through which decisions are taken – we were completely ‘allergic’ to those types of charts with lots of boxes with different committees and researchers and so on, leading ultimately to a conclusion, because an excess of process is very damaging. And then we added one more – ‘reporting’ – because it is astonishing, particularly in the private client world, how poor reporting is. You have reports that show everything but performance – and the client does need to know what the performance was. And, sometimes, if performance is reported, it is only the last quarter’s performance – and I’m amazed, really, at how the industry gets away with it.

SA: And when you are making that judgement on, for example, the people part of your analysis, presumably you have some fund managers who are very slick, very impressive presenters and you have others who turn up wearing the wrong clothes and pour the tea over you – so how are you making the judgement to avoid the smooth ones or whatever it might be?

RO: We were conditioned to be wary of very slick presentations. In fact, I adopted something called the ‘counter-presentational principle’, which is that, if a fund manager makes a very bad – in presentational terms – presentation, then he may well be a very good manager! It was originally named – and I will now name him! – the ‘Ritchie principle’ after a lovely colleague, who was a fixed interest manager at Mercury. He was very good at his job but he would come into the office, as you say, pour tea down his tie, drop all his papers on the floor, rummage around saying, ‘I know it’s in here somewhere’ – but he was a very good fund manager. And one did always think, Well, he is so bad at getting his papers in order, he must be good!

And some of the best managers have been the most reluctant to present. I am sure you will know of Gordon Grender, who used to manage US portfolios at GAM – he absolutely loathed making presentations and he made that very clear! I remember him being dragged into the office by a colleague and we did have a very good conversation but, from time to time, he would say, I hate doing this – I never do this! So, as a fund manager myself, and working with other fund managers, I think it was easier to get under the skin of fund managers who we were seeing and to actually have a good conversation – and a frank conversation.

SA: Have you found that, ironically, when you are talking to someone who understands all the potential weaknesses and all the challenging questions, it almost gives you the opportunity to open up?

RO: Yes. In fact, going back to 1999 or possibly early 2000, I came to see Jim Cox, who I imagine is still a revered figure at Schroders, despite dying more than 10 years ago. Schroders at that time was managing a fund for the family office I worked for and I said, Jim, you had 20 years doing wonderfully for a whole lot of people, you have done three years now very badly for us, we want to recommend you have more money – but it just occurred to me, you might be thinking, Sod it, I’ve had enough of this! There was a very long pause and he said, Well, I am in fact in negotiation with the management of Schroders. So I then stuck very close to him and, in due course, he left Schroders, and we got him to join Alta, where he ran UK portfolios extremely well – and in exactly that glowing period, from 2000 to 2007, when somebody like Jim was needed. So, yes, I think that as a fund manager one had better conversations with fund managers.

Learning investment lessons from life

SA: Let’s change direction yet again – you have had an incredibly varied life and career beyond fund management and done lots of very interesting things. Are there any particular areas you think have really helped you in fund management – whether that be dealing with the pressure or learning things or whatever? I’m aware, for example, you did a lot of work with the Probation Service.

RO: Well, I wrote a report for the Probation Service but, until this moment, I cannot say I thought I learned anything from it that was useful in fund management! But, of course, life is useful in fund management – and you never quite switch it off. When you go to Sainsbury’s, for example, you think about how the place looks – whether it is full of people, whether the cereal packages are well presented, whether people are smiling, whether the service is good and so on. And, when you are in an aeroplane, you think about the load factor and so on. But the Probation Service was very interesting to do and one of the things I did learn there – and maybe this is relevant – related to risk.

The Ministry of Justice is enormously risk-averse, for reasons one can well understand, because terrible things happen, such as The Fishmongers’ Hall murders, for example – the London Bridge murders. And I fear that concern about an individual and improbable, awful and tragic failing like that can translate into an institutional risk aversion that leads to them not trusting people they should trust to provide services to them – in particular, all the small charities that are their natural partners. That is because these smaller organisations are then faced with responding to enormous 909-page contracts, that type of thing, which a small or medium-sized charity cannot possibly do.

And there are two things I would say about that – the first is never to forget the laws of probability, which include the point that improbable things sometimes happen. That has been very important in the last few years, with two highly improbable things happening, in the shape of Covid and Ukraine. And then the second point is on trust – and this applies very strongly in the selection of fund managers. In Britain, as a whole, and perhaps in the world, we are very short on trust at the moment. We have lost trust in all our major institutions. I am very wary of phrases like ‘institutional racism’ – because I think that brands every member of the police force, for example, a racist – but there are areas of systemic failure, where there may have been systemic racism and, therefore, it is hard not to lose trust.

On the whole, though, one should try to find people who one trusts and then give them trust, have confidence in them and see them through tough times in life generally – and, in fund management, that applies very strongly in the interests of the person who owns the money, for two reasons. One, I think they will get a better return over the long term; and, two, distrust is so corrosive.

SA: Particularly in fund management where, if you feel someone does not trust you, chances are fund managers will edge closer to that benchmark you talked about, which is where you don’t want them.

RO: Now, you are talking about a lack of trust being corrosive to the manager. I was thinking more about the person who is doing the trusting – or distrusting. I think it is corrosive of oneself to distrust – and it is better to trust and sometimes be disappointed than not to trust at all.

SA: Yes. Now, you have said you have value investing in your blood – which is something I can empathise with. So are there any obvious examples from your personal life – you know, where you can’t help but buy the cheap car instead of the good one?

RO: I mean, that is when you have what we call a ‘value trap’. I think that is a constant failing and the occupational hazard of the value manager – that you are attracted by low valuations. Sometimes there is a reason for the low valuation, which is something is going wrong or has gone wrong – and sometimes that thing that has gone wrong does not get better and then you look daft. Yet that is precisely why, as an investment philosophy, value works – because it is emotionally difficult.

It is not so emotionally difficult to be a growth manager, when you are investing in successful companies that have 15% or 20% growth or more and you are more indifferent to the valuation. If it goes wrong, you will still have been investing in a company that was doing very well – but to invest in a company that is doing badly and going through a rocky time and then the share price collapses on you, that makes you look pretty foolish. So I think a value investor has to get used to looking foolish. And of course you try to minimise the risks of this happening but there are no real escapes – and, thinking back to quality, that focus on quality of assets and quality of balance sheets is very important to try to limit the number of value traps you buy into.

SA: And when you have recruited people – which is a bit different from choosing a fund manager when you are managing other people’s money – how do you try and assess whether or not people have the temperament and the resilience to then keep going in year three of a tough patch?

RO: Well, that is a very good question – and I think there are two distinct qualities here. One is the disposition to be a value investor, which as I say is in the blood, and that comes out pretty easily from hearing how somebody talks about investing in a company and what they refer to first – do they refer to valuation first or do they refer to growth first? And I think, you know, the value investor goes to the table in the investment casino, where the croupier or the banker is pushing chips in your direction – not very many chips, perhaps, but enough to comprise a favourable probability. At the growth table, in contrast, the banker is taking your wages because there are so many people at the growth table who are optimistic and expect 20% earnings growth – and 20% earnings growth year after year after year just never happens. And so there is plenty of room for disappointment whereas, at the value table, there is room for nice surprises.

So the disposition to be a value investor, I think, is quite easy to detect. Resilience is not so easy to detect – you know, I don’t have any secret way to work out who is going to turn out to be resilient and who is not! And it is a stressful business. I have always joked that performance fees should be paid to managers who are underperforming because it is stressful when you have to perform! And it isn’t in the least bit stressful when you are outperforming – in fact, life seems pretty easy when you are outperforming. So value investing is stressful and you do have to be able to handle that stress and retain persistence and consistency.

SA: That is something else we would totally agree with. Now, I am conscious of time so thank you very much for speaking so openly and candidly about so much – and best of luck.

RO: Thank you very much. It has been a great pleasure.

SA: Thank you.